Russia Country Risk Report & Analysis

Second wave of Covid-19 and low oil prices curtail recovery in 2021

SENSITIVE RISK for enterprise

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

Economic risk
Business environment risk
Political risk
Commercial risk
Financing risk

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GDP

USD1,700bn (World ranking 11, World Bank 2019)

Population

144,37mn (World ranking 9, World Bank 2019)

Form of state

Federation

Head of government

Vladimir Vladimirovich PUTIN (President)

Next elections

2021, legislative

Abundant natural resources, in particular oil and gas
More than 20 years of continued current account surpluses (including the crisis years 2009, 2015-2016 and 2020)
Low public debt
Comfortable foreign exchange reserves

Far-reaching structural reforms still outstanding
High vulnerability to global oil price shocks
Prone to capital flight
Exchange rate remains vulnerable to volatility and sudden depreciation
Prolonged recession has adversely affected corporate profitability
Poor rule of law and high level of perceived corruption
Geopolitical risks: Conflict with Ukraine and serious dispute with the West over that conflict (including sanctions and counter-sanctions). Also involved in Syria crisis

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Return to moderate growth in 2021?

The Russian economy contracted by -3.1% in 2020 as a result of the impact of the global Covid-19 crisis, as well as the marked decline in oil prices. Relatively strict lockdown measures at the beginning of the pandemic led to a sharp drop in domestic demand. In particular, private consumption – which had been a solid growth driver in recent years, thanks to falling unemployment and low inflation – contracted by -8.6% in full-year 2020 as a result of the lockdown in spring, social distancing and rising unemployment. Fixed investment also declined markedly by -6.2% as companies were reluctant to invest amid the lingering uncertainty and rather wanted to preserve liquidity. Meanwhile, government consumption growth offset the declines in consumer and capital spending to some extent as it expanded by +4%, thanks to some targeted fiscal stimulus. As seen elsewhere, external trade activity weakened significantly, but since real imports (-13.7%) dropped more strongly than exports (-5.1%), net exports made a positive contribution of +1.3pp to the overall change in real GDP in 2020, making the full-year contraction comparatively mild.

Looking ahead, we forecast real GDP to grow by +2.5% in 2021. Owing to a strong second wave of Covid-19 cases in Russia and in Europe in late 2020 and early 2021, renewed lockdown measures will weigh on domestic and external demand. We expect a weak start to the year 2021, with flat growth in Q1, followed by a Q2 in which the authorities are likely to be more cautious than in summer 2020 with regard to the reopening of the economy. Vaccination against Covid-19 could have a positive impact on the economy in H2 2021, but we do not expect too much yet this year as sufficient provision and distribution of potential vaccines to the population will take time. Low oil prices are another factor holding back potential growth. We forecast an average global oil price of USD48/bbl in 2021 and USD57/bbl in 2022. Our tentative forecast for real GDP growth in 2022 is +3%.

Economic policies are moderately supportive during the crisis

Cautious and well-tuned economic policies have provided some cushion against the new sanctions that have been imposed against Russia since 2018 and should continue to do so in the near term. These include monetary policy credibility, diligent fiscal policy and export diversification. Furthermore, the Russian government is pursuing the de-dollarization of the economy – a multi-year drive to reduce exposure to US assets pushed the share of gold in the Central Bank of Russia’s total international reserves above the USD share for the first time on record. In June 2020, gold accounted for 23% of the reserves while the share of USD assets had fallen to 22% from more than 40% in 2018. A reduced dependence on the USD lowers the vulnerability to external shocks.

Monetary policy to remain well-tuned and credible

In the aftermath of the currency crisis and the resulting surge in inflation in 2014-2015, the Central Bank of Russia (CBR) embarked on a credible inflation targeting regime under Governor Elvira Nabiullina. Monetary policy was gradually eased in line with falling inflation until mid-2018. When inflation expectations began to rise again due to the anticipated VAT hike in 2019, policy interest rates were pre-emptively hiked from September 2018. Then, in June 2019, the CBR changed course again and cut its key policy interest rate by a cumulative 150bp to 6.25% in December 2019, citing slowing inflation and the weak economic momentum in most of 2019. Monetary easing was continued in 2020 in order to mitigate the impact of the Covid-19 crisis on the economy. The policy rate was cut by another cumulative 200bp to 4.25%.

Crucially, the policy rate remained above the inflation rate until October 2020. Thereafter it picked up to 5.2% y/y in January 2021, in part due to a strong increase in volatile food prices. This has reduced the chance of an interest rate cut in 2021. However, the CBR should also not overreact and hike rates since we expect headline inflation to fall back to around 4% by the end of the year.

Governor Nabiullina has also shut down many non-viable banks, though more needs to be done on this end. Overall, the CBR continues to enjoy a high degree of independence and credibility, especially as compared to peer countries.

Nonetheless, currency risk remains on the agenda, although an equally steep RUB depreciation as in 2015 (-59% vs. the USD on average) is highly unlikely until end-2020. But after rebounding by +13% in 2017, the RUB experienced volatility again and lost on average -8% in 2018, -3% in 2019 and -10% in 2020, mainly responding to sharp oil price moves or disturbing political events, including new sanctions.

Fiscal prudence has been relaxed but not abandoned

Fiscal policy has been diligent in Russia in recent years. In the wake of the currency crisis and recession in 2015-2016, Russian authorities have prioritized financial stability over economic growth. Public spending growth was modest in 2017-2019 (average annual +2.1%) before picking up to +4% in 2020 due to some stimulus to mitigate the impact of the Covid-19 crisis. Yet, government expenditure in Russia is still fairly moderate as compared to other countries, accounting for around 35% of GDP. This is, for example, similar to the ratio in China but lower than that in South Africa (39%), Poland (41%) and Hungary (47%), as well as the EU average (46%). At the start of 2019, the government increased the VAT rate from 18% to 20%, a step in the right direction in order to diversify its fiscal income base and reduce its vulnerability to global commodity prices.

However, the Russian government had also announced a set of so-called National Projects, an investment program estimated at RUB25tn (about USD400bn) running from 2019-2024. The aim was to boost growth and living standards, which have suffered markedly since the 2015-2016 crisis. But this program did not really take off in 2019 and suffered a setback in 2020 due to the crisis. It remains to be seen whether this program will gain traction again, but we expect at least some fiscal stimulus with positive growth effects to come, especially as there will be legislative elections in 2021.

After two years of annual surpluses, Russia’s fiscal balance shifted into an estimated deficit of -4.7% of GDP in 2020 in the wake of Covid-19. We forecast further but smaller deficits of -2% in 2021 and -1.3% in 2021. Overall public debt will increase from 14% of GDP in 2019 to a projected 20% at the end of 2021, but this will still be a relatively low ratio compared to Emerging Market peers.

External position remains comfortable

Russia’s current account balance has recorded continued annual surpluses since 1998 - on average +5.8% of GDP and including the crisis years 2009, 2015-2016 and 2020. In 2020, the surplus narrowed to approximately +2% of GDP from +3.8% in 2019 because nominal exports of goods and services dropped more sharply by -23% while imports fell by -14%. Looking ahead, we expect nominal exports to rebound more strongly than imports, thanks to base effects, somewhat higher oil prices and a gradual tapering of oil output cuts agreed with OPEC and some other major oil producers. As a result, the annual external surplus should widen to about +2.5% in 2021-2022.

Meanwhile, private-sector net capital outflows from Russia increased to -USD48bn in 2020 from -USD22bn in 2019, but remained well below the record highs in 2014 and 2008 and also below the annual average over the last 10 years (-USD59bn). In 2021, we expect net capital outflows to reach a similar amount as in 2020 as low oil prices and the threat of new or stepped-up foreign sanctions will keep investors wary.

Official foreign exchange (FX) reserves excluding gold held at the CBR suffered from modest temporary outflows in March-June 2020 in the wake of the Covid-19 outbreak but recovered thereafter and grew overall from USD444bn in December 2019 to USD454bn in January 2021. Current FX reserves are very comfortable in terms of import cover, which has risen to 18 months from 15 months at end-2019 (and a low of nine months at end-2014), mainly owing to the drop in imports. In other terms, FX reserves cover more than 350% of the estimated external debt payments falling due in the next 12 months (>125% is assessed as comfortable).

Gross external debt declined to USD470bn at the end of 2020, down from USD491bn a year earlier. The decline in 2020 was mostly reflecting corporate and bank deleveraging during the crisis. The current level of external debt is still moderate in relation to GDP (approximately 31% at end-2020) and export earnings (127%). The debt-service ratio is forecast at a manageable level of around 20% in both 2021 and 2022. - February 2021.

Trade structure by destination/origin

(% of total)

Exports	Rank	Imports
China 9%	1	22% China
Germany 8%	2	12% Germany
Turkey 5%	3	5% Belarus
Belarus 4%	4	4% Italy
United States 4%	5	4% France

Trade structure by product

(% of total)

Exports	Rank	Imports
Petroleum, petroleum products and related materials 48%	1	10% Road vehicles
Iron and steel 7%	2	7% Other industrial machinery and parts
Non-ferrous metals 5%	3	6% Articles of apparel & clothing accessories
Coal, coke and briquettes 4%	4	6% Electrical machinery, apparatus and appliances, n.e.s.
Fertilizers other than group 272 3%	5	5% Medicinal and pharmaceutical products

The payment behavior of domestic firms is often poor and the businesses themselves have complex legal structures. Payment terms are not fully regulated and Russian counterparties try to renegotiate conditions, requesting postponement of payments or ignoring contractual obligations.

Low
Medium
Sensitive
High

Payments
Court proceedings
Insolvency proceedings

Payments
Court proceedings
Insolvency proceedings

Courts can be fairly efficient when a debt is certain and undisputed, but legal proceedings may otherwise be complex (no default judgments, no fast track proceedings above EUR 4,000 even if the debt is certain and undisputed) and cannot be avoided through Alternative Dispute Resolution methods(which is not relied upon) or through foreign courts (since Russian courts apply extremely strict jurisdictional exclusivity rules).

Insolvency proceedings ought to be avoided. A debt renegotiation mechanism isindeed available, although it is unused in practice. Liquidation is therefore the default procedure, but unsecured creditors would have very limited chances of recovering their debt.